Journal of Investment Strategies

Tail-risk mitigation with managed volatility strategies

Anna A. Dreyer and Stefan Hubrich

  • The Sharpe Ratio benefit of managed volatility strategies is period dependent. 
  • Volatility stabilization consistently removes tail risk from the return distribution.
  • The tail risk enhancement is economically meaningful within a utility-based framework.

Managed volatility strategies adjust market exposure in inverse relation to a risk estimate, to stabilize realized portfolio volatility through time. Our paper examines strategy performance from an investment practitioner perspective. Using long-term data from the Standard & Poor’s 500, we show that these strategies offer an improvement in risk-adjusted return compared with a buy-and-hold benchmark, on average, but with some variation. Managed volatility strategies achieve robust tail-risk reduction while also enhancing skewness. These return normalization features are inherently linked to the nature of the volatility stabilization mechanism. We illustrate them via utility-based metrics that reward the tail-risk reduction emanating from volatility stabilization.  These enhancements are economically  meaningful  for many time horizons and holding period combinations, and they remain once transaction costs have been included, suggesting a durable and tangible value-add from managed volatility strategies. They also suggest a more appropriate way to measure the performance improvements of tail-risk-mitigating strategies.

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